Monday, April 25, 2011

Equity Week in Review and Preview of the Upcoming Week/Month

Last week I wrote the following about the markets:

For the last few weeks, I've felt the market was going to be moving sideways. That is still my general analysis. I don't see any reason for a major correction right now; instead, I believe the markets and traders are in a wait and see position.

The market is facing some strong headwinds: the end of QEII, China tightening, Japan recovering from its earthquake, high gasoline prices, budget stupidity in Washington, continuing EU problems and high commodity prices. We're currently seeing a wave of first quarter GDP downward revisions, which will probably continue as we go forward. However, as I will write throughout this week, the latest Beige Book is surprisingly strong -- much stronger than I originally anticipated. This should give traders pause is selling all their positions.
I would now add two more concerns. The first is a big drop in consumer sentiment, as reported by the NY Times:
Americans are more pessimistic about the nation’s economic outlook and overall direction than they have been at any time since President Obama’s first two months in office, when the country was still officially ensnared in the Great Recession, according to the latest New York Times/CBS News poll.
The article notes that with high gas prices and still high unemployment, people have little to be happy about. This drop was also noted in the latest LEI release from the Conference Board which I analyzed here.

The second issue is a drop in the Philadelphia area manufacturing index last week.
Results from the Business Outlook Survey suggest that regional manufacturing activity continued to grow in April but at a slower pace than in March. Nearly all of the survey’s broadest indicators remained positive but fell from their readings in the previous month. Increases in input prices continue to be widespread, and a significant percentage of firms reported increases in prices for their own manufactured goods. The survey’s indicators of future activity fell notably this month; however, most firms expect continued growth over the next six months.
This is only one month worth of data, so take the concern with a large grain of salt. The NY Fed had a similar drop late last year, and came roaring back. However, the overall timing couldn't be worse. In short, the macro environment is turning neutral, which I believe will prevent a strong upward move in the equity markets.

Let's go to the charts:

On the daily five minute chart we see an upward bias. However, On Wednesday and Thursday prices gapped higher at the open but did not follow through. That means that a futures move kicked off trading higher, but there was no reason throughout the day to keep buying shares. As such, we see the following on the SPYs:

Note the very weak candles on the chart, which are accompanied by low volume. The EMAs are also in a tight bunch, indicating a lack of overall direction.

Adding to my overall concern are the transports:

Note the incredibly low volume and lack of any meaningful upward movement last week. The 10 day EMA has just recently turned higher and the upward angle of the 20 day EMA is very weak. Furthermore, prices rallied to the 97.5 area, only to fall quickly -- and that was after a big gap higher. Recently, prices have not mirrored the upward move of the broader equity markets, which is very concerning.

The Russell 2000 (IWMs) are also in pretty weak shape. While prices have gapped higher the last two days, the candles printed have been very weak and on low volume. And, the EMAs have the same problem as the SPYs EMAs.

In short, I still see the markets taking a wait and see attitude right now. There is concern about the underlying fundamentals that I believe will eventually weigh down any advance. Any move above technically important levels should be viewed with extreme caution unless accompanied by a fundamentally altering event such as a great unemployment report, a clear policy change from Washington that creates more fiscal stimulus, or a good GDP report that surprises the markets. I see the SPYs as being contained by the 134.5 level, the QQQs contained by the 59 level and the IWMs contained by the 86 level. I also see the possibility of prices beginning a consolidation phase where they form a standard consolidation pattern such as a triangle or rectangle.

This week we have consumer confidence which will provide much needed more data on the consumer's sentiment, along with durable goods orders and GDP. I am very interested to see how GDP prints and more specifically its overall internals.

While it is possible that I am reading the tea leaves too conservatively right now, I believe the fundamental backdrop warrants such concern. For more detail, see this link.